The U.S. economy, for the moment, continues to send mixed signals that we believe are very indicative of the existing high-risk and low-growth environment. For example, nonfarm payrolls grew by a better-than-expected 146,000 in November, and the unemployment rate surprisingly declined by two-tenths to 7.7 percent; but due to downward revisions to the prior two months data, the three-month average rate of job creation has now slipped a couple of notches to 139,000 as of November from what was previously a much healthier 170,000 in October.
The two-tenths decline in the unemployment rate also partially reflects restrained growth in the civilian labor force since June of this year, or even since the prior peak of the labor market during the financial crisis in 2008 on a longer-term basis. The civilian labor force declined to 155.3 million in November from 155.6 million in October (the current high watermark), just above the prior cyclical peak of 154.9 million recorded in October 2008. Under normal circumstances, the labor market typically expands during recovery as the labor market tightens and previously disenchanted individuals return to the labor force.
U.S. GDP growth actually improved significantly in the third quarter to 2.7 percent, from just 1.3 percent in the second quarter, but other barometers of business activity reveal reasons for reduced optimism. Trends in the average quarterly readings of the Institute for Supply Management’s (ISM) Purchasing Managers Index (PMI) in conjunction with quarterly S&P 500 corporate revenue and earnings growth rates come close to summarizing our current view of the economy and financial markets.
This particular perspective suggests that economic activity, and by extension corporate revenue and profit growth, has been slowing for many months now and we may not be too far from the point where recession risks start becoming more worrisome. All three barometers are approaching the zero-boundary and the current direction of this trend is not encouraging. We would normally be quite concerned with such risks on a stand-alone basis, but within the context of negotiations to redefine U.S. fiscal policy while avoiding looming automatic tax hikes and sequestration, this picture could quickly become downright scary.
We still believe that the U.S. economy will continue to crawl forward at the underlying 1 percent to 2 percent GDP growth rate, or possibly even at a healthier pace, if the fiscal cliff is resolved efficiently, and most importantly, in a credible manner. However, we must also acknowledge that risks remain very high. If conditions deteriorate even a little further, the U.S. economy will be starting 2013 in a much weaker and vulnerable position than at the start of 2012. Negotiations to resolve the cliff constitute a significant dose of fiscal tightening at a time when the economy is not fundamentally strong. The Federal Reserve has already done almost everything within its power to support what has so far been a historically lackluster recovery. So what policies will be put in place to offset restraint associated with the resolution of the fiscal cliff?
We believe that Washington needs to reach a compromise solution that successfully dissolves the fog of uncertainty and indecision that has hampered GDP growth this year and since the start of this recovery in 2009. A stimulus-dividend in the form of increasing business confidence and optimism, along with ongoing extreme monetary accommodation from the Fed, represents the best prospect for offsetting the fiscal restraint that will be forthcoming from Washington D.C. in the weeks ahead.
The level of risk associated with the equity and corporate debt markets is poised to tick higher next year if U.S. economic fundamentals deteriorate from where we stand today. Expected calendar-year 2012 S&P 500 corporate earnings have reached a new low watermark this past week of $102.52, having been as high as $106.49 earlier this year on April 25, 2012. Expected 2012 S&P 500 corporate earnings per share had previously been as high as $113.41, roughly a year and a half ago on July 29, 2011. Looking ahead, calendar-year 2013 earnings are currently expected to be $113.00 per share, according to the S&P Capital IQ consensus. This is slightly lower than what was originally foreseen by Wall Street analysts for 2012, right around the time when Standard & Poor’s Ratings Services lowered its rating on the U.S. from 'AAA'; food-for-thought as Washington debates the fiscal health and path of the U.S. going forward.
Thompson is managing director, S&P Capital IQ Global Markets Intelligence.